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Revised Summer 20156 Chapter Review

COST-VOLUME-PROFIT ANALYSIS

Key Terms and Concepts to Know


Contribution Income Statement:
 Separates expenses into variable and fixed.
 Sales – Variable Expenses = Contribution Margin.
 Contribution Margin – Fixed Expenses = Net Income (Loss).

Contribution Margin:
 The amount of sales available to cover fixed expenses with any remaining
contribution margin providing profits.
 If the contribution margin is not sufficient to cover fixed expenses, there will be a
net loss for the period.

Contribution Margin Ratio:


 Sales, variable expenses and contribution margin are all variable, and therefore
may be expressed as a percent of revenue.
 The contribution margin ratio is calculated as the contribution margin dollars as a
percent of sales dollars.
 The variable expense ratio is the complement to the contribution margin ratio. It
represents the percent of sales dollars not included in the contribution margin
ratio.
 In a company producing a single product, this relationship applies to either total
sales dollars and total contribution margin or per-unit sales dollars and
contribution margin dollars.
 In a company producing multiple products, each product will have its own unique
contribution margin ratio. The contribution margin for the entire company will be
calculated only for total contribution margin dollars as a percent of total sales
dollars.

Break Even Point:


At the breakeven point:
 Operating Income = 0
 Total revenue = total expenses
 Fixed Expenses = Contribution Margin

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Target Profit:
 Rather than setting operating income = 0, target profit calculations assume a
certain operating income and calculate the sales dollars and units sold necessary
to achieve it.
 The same equations are used as to calculate the breakeven point, except that a
non-zero operating income term is included in the numerator.

Margin of Safety:
 The margin of safety is the excess of budgeted or actual sales over the breakeven
volume of sales.
 It is expressed as both the dollar amount of the difference and as a percent of
budgeted or actual sales.

Sales Mix:
 Companies that sell more than one product make the breakeven and target profit
calculations a bit more complex.
 Each product has its own breakeven equation and sales volume, none of which
represents the breakeven equation for the entire company. A breakeven equation
can be developed for the whole company by combining the breakeven equations
and sales volumes (the sales mix) for the individual products.
 The sales mix is assumed to remain constant to simplify the calculations.
 Changes in sales volume are assumed to be in the constant sales mix.

Operating Leverage:
 Operating leverage quantifies, at a given level of sales, the percent change in
operating income caused by a percent change in sales.
 Leverage calculations are a two-step process:
o First, calculate the Degree of Leverage or Leverage Factor
Contribution Margin
Degree of Leverage =
Operating Income
o Second, calculate the percent change in operating income:
Percent change in Degree of Leverage x Operating Income
=
operating income

Cost Structure and Profit Volatility:


 Cost structure refers to the proportion of variable costs and fixed costs in the total
costs incurred during the period.
 No one cost structure is the right one. Different industries have different cost
structures and management may work to change the company’s cost structure in
response to changing business conditions and expectations.

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Key Topics to Know

Breakeven Equations

 The breakeven point is expressed in sales dollars and units sold. The link
between the two is selling price per unit, meaning that breakeven units sold x
selling price per unit = breakeven sales.

 The breakeven equations are:


Breakeven Fixed expenses + operating income
=
sales Contribution margin ratio

Breakeven = Fixed expenses + operating income


units Contribution margin $ per unit
Note that since operating income = 0 at the breakeven point, this term is
frequently dropped from the equations.
 Breakeven problems are made more complex because some information is given
in per-unit amounts, other information is given in total dollars and still other
information is not dollars but units sold.
 A useful tool to collect and analyze the various data items is:

Per Unit Percent Total


Units 1
Sales 100%
- Variable costs
= Contribution Margin
- Fixed costs
= Operating Income

o The Units line may be given or may be a variable to solve for.


o The Per Unit column records only the three variable items: sales, variable
costs and contribution margin.
o The Percent column calculates the three variable items: sales, variable costs
and contribution margin as a percent of sales.
o The Total column contains the entire income statement.

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Example #1

W Company sells only one product with a selling price of $200 and a variable cost of $80
per unit. The company’s monthly fixed expense is $60,000.

Required: Determine the breakeven point in units sold and sales dollars.

Solution #1

CM ratio = Sales – variable expenses = $200–80=120


Sales $200
= 60%

Breakeven sales = Fixed expenses + operating income = $60,000 + $0


Contribution margin ratio 60%
= $100,000

Breakeven units = Fixed expenses + operating income = $60,000 + $0


Contribution margin $ per unit $120
= 500 units

Target Profit

 The same equations are used as to calculate the breakeven point, except that the
target profit is included in the numerator.
 An alternative solution starting from the breakeven point is also possible.

Example #2

L Company sells only one product with a selling price of $200 and a variable cost of $80
per unit. The company’s monthly fixed expense is $60,000. The corporation would like
to achieve a profit of $30,000 next year.

Required: Determine the units to be sold and sales dollars necessary to


achieve the target profit.

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Solution #2

Sales – variable expenses $200–80=120


CM ratio 60%
Sales $200

Fixed expenses + operating $60,000 +


Sales income $30,000 $150,000
Contribution margin ratio 60%

Fixed expenses + operating $60,000 +


Units income $30,000 750 units
Contribution margin $ per unit $120
OR
Units Sales $150,000
750 units
Selling price per unit $200

Alternate Solution:
Additional units Target profit $30,000
Contribution margin $ $120 250 units
per unit

Total units Breakeven units + 500 + 250


750 units
units to reach target

Additional sales Additional units x 250 x $200


$50,000
selling price

Total sales Additional sales + $150,000 +


$200,000
breakeven sales 50,000

Example #3

S Company sells pillows for $90 per unit. The variable expenses are $63 per pillow and
the fixed costs are $135,000 per month. The company sells 8,000 pillows per month.
The sales manager is recommending a 10% reduction in selling price, which he believes
will produce a 25% increase in the number of pillows, sold each month.

Required: Prepare contribution margin income statements for current


operating conditions and if the proposed changes are made.

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Solution #3

Present Proposed
Per Unit % Total Per Unit % Total
Units 1 8,000 1 10,000
Sales $90 100.0 $720,000 $81 100.0 $810,000
Variable expenses 63 70.0 504,000 63 77.8 630,000
Contribution Margin 27 30.0 216,000 18 22.2 180,000
Fixed expenses 135,000 135,000
Operating income $81,000 $45,000

8000 Pillows X 1.25 = 10,000 pillows; $90 per pillow X .9 = $81 per pillow

Since the operating income decreased by $36,000, from $81,000 to $45,000, the sales
manager’s suggestion should not be implemented.

Margin of Safety

Example #4

Using the data in Example #3, determine the margin of safety under current operating
conditions.

Solution #4

Present Breakeven
Per Unit % Total Total
Units 1 8,000 5,000 $450,000/$90
Sales $90 100.0 $720,000 $450,000 $135,000/30%
Variable expenses 63 70.0 504,000 315,000 $450,000x70%
Contribution Margin 27 30.0 216,000 135,000 fixed + OI
Fixed expenses 135,000 135,000 stays the same
Operating income $81,000 $0 Always $0

Margin of Safety = $720,000 - $450,000 = $270,000 or 37.5%

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Sales Mix

Example #5

Z Company sells two models of doghouses, the Puppy Palace and the Canine Castle.

Puppy Canine
Palace Castle
Sales price per unit $50 $75
Variable cost per unit 30 50
Contribution margin per unit $20 $25

Z Company has determined that it would break even at an annual sales volume of
50,000 units, of which 75% would be Puppy Palaces.

Required: a) What are the contribution margin ratios for each product and the
company?
b) What is the amount of Sanchez's estimated annual fixed costs?
c) What is the sales mix?
d) Prepare a product line income statement with operating income of
$400,000. Fixed production costs will increase $45,000 and fixed
administrative costs will increase $22,500 to support the increase
in volume.

Solution #5

a)
Puppy Canine Sanchez
Palace Castle Company
Volume 50,000 50,000
75% 25%
37,500 12,500

Sales $1,875,000 $937,500 $2,812,500


Variable cost 1,125,000 625,000 1,750,000
Contribution margin $750,000 $312,500 $1,062,500
Contribution margin ratio 40.00% 33.33% 37.78%

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b)
Puppy Canine Sanchez
Palace Castle Company
Sales $1,875,000 $937,500 $2,812,500
Variable cost 1,125,000 625,00050 1,750,000
Contribution margin $750,000 $312,500 $1,062,500
Fixed costs 1,062,500
Operating Income $0

At the breakeven point, fixed costs always equal contribution margin.

c) The sales mix can be expressed as 3:1 based on the ratio of 37,500 units : 12,500
units. This means that when sales volume increases, it will be in groups of four
units (3 puppy palaces and one canine castle). Each group will have a sales value
of $225 = 3 x $50 + 1 x $75 and a contribution margin of $85 = 3 x $20 + 1 x
$25.

d)
Puppy Canine Sanchez
Palace Castle Company
Volume in groups of 4 units 18,000 18,000
Sales mix 3 1
Product units 54,000 18,000

Sales $2,700,000 $1,350,000 $4,050,000


Variable cost 1,620,000 900,000 2,520,000
Contribution margin $1,080,000 $450,000 $1,530,000
Fixed costs 1,130,000
Operating Income $400,000

Fixed costs = $1,062,500 + 45,000 + 22,500


Contribution Margin = $400,000 + 1,130,000
Company Sales = $1,530,000 / .3778

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Operating Leverage

Example #6

P Company sells pillows for $90 per unit. The variable expenses are $63 per pillow and
the fixed costs are $135,000 per month. The company sells 8,000 pillows per month.

Required: Compute the degree of leverage and the expected operating


income if sales increase 10%.

Solution #6

Present Proposed
Per Unit % Total Total
Units 1 8,000 8,800
Sales $90 100.0 $720,000 $792,000
Variable expenses 63 70.0 504,000 554,400
Contribution Margin 27 30.0 216,000 237,600
Fixed expenses 135,000 135,000
Operating income $81,000 $102,600

Degree of leverage 2.67


Percent increase in sales 10%
Percent increase in operating income 26.7%
X operating income $81,000
Increase in operating income $21,600
Present operating income 81,000
Proposed operating income $102,600

Cost Structure and Profit Volatility

 The proportion of variable to fixed costs will have a significant effect on operating
income as the level of sales changes:
o A higher proportion of fixed costs means a lower proportion of variable
costs and a higher contribution margin ratio and contribution margin per
unit.

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o A higher contribution margin ratio means a higher volatility for operating


income and that a change in units sold will have a proportionately larger
effect on operating income.
o A lower proportion of fixed costs means a higher proportion of variable
costs and a lower contribution margin ratio and contribution margin per
unit.
o A lower contribution margin ratio means a lower volatility for operating
income and that a change in units sold will have a proportionately smaller
effect on operating income.
 Consider the results of two similar companies with the same initial revenues,
total costs and operating incomes:

Current Sales Level


Company A Company B
Units sold 100 100
Sales $1,000 $1,000
Variable 700 300
CM 300 700
Cm ratio 30% 70%
Fixed 200 600
Oper. Income 100 100

Now consider how changes in the sales level affect operating income:

Sales Increase of 50% Sales Decrease of 20%


Company A Company B Company A Company B
Units sold 150 150 80 80
Sales $1,500 $1,500 $800 $800
Variable Costs 1,050 450 560 240
CM 450 1,050 240 560
CM ratio 30% 70% 30% 70%
Fixed Costs 200 600 200 600
Operating
Income 250 450 40 (40)

Company A had higher variable costs and lower fixed costs, a lower CM
ratio and lower income volatility when units sold changed: income increased
$150 ($100 to $250) or decreased $60 ($100 to $40).

Company B had lower variable costs and higher fixed costs, a higher CM
ratio and higher income volatility when units sold changed: income
increased $350 ($100 to $450) or decreased $140 ($100 to a loss of $40).

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Practice Problems
Practice Problem # 1

M Company produces only one product, organic fruit baskets, which it sells for $90 each.
Unit variable costs are $63 and total fixed expenses are $21,000. Actual sales for the
month of May totaled 2,000 units.

Required: Compute the margin of safety in dollars and percentage for the
company for May.

Practice Problem #2

T Company reports the following results for the month of November:

Units sold 10,000


Sales $600,000
Variable costs 420,000
Contribution margin 180,000
Fixed costs 96,000
Net income $ 84,000

Management is considering the following independent courses of action to increase net


income.
I. Increase selling price by 10% with no change in units sold.
II. Reduce variable costs to 50% of sales.
III. Reduce fixed costs to $75,600

Required: a) Prepare a breakeven income statement


b) Prepare a breakeven income statement for each proposed course
of action
c) Calculate the contribution margin ratio for each alternative

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Practice Problem #3

The H Company had wine sales for December as follows:

Red White Champagne


Bottles sold 100 40 60
Average selling price $80 $45 $60
Average cost $40 $15 $15

The wine director’s salary is $36,000 per year plus tips, which average $160 per month.

Required: d) Prepare an income statement by type of wine and in total for


December.
e) Prepare a breakeven income by type of wine and in total
statement for December.

Practice Problem #4

I Company reported the following results from its income statement for the year:
Sales of $1,000,000 for 10,000 units sold. Contribution margin ratio was 30% and
operating income was 10% of sales. Units sold are expected to increase 10% next year
and an additional 20% the year thereafter with no changes in fixed expenses.

Required: Using operating leverage calculations, compute the operating


income for the year.

Practice Problem #5

F Company is debating whether to purchase new equipment that would increase fixed
costs from $96,000 to $196,000, and decrease variable costs from $14 per unit to $8
per unit. If it were to implement the change at its current production level of 100,000,
profit would not change. Selling price is $20 per unit.

Required: a) What would happen to the company's profit if the change were
implemented and production decreased to 15,000?
b) Prepare a breakeven income statement if the new equipment was
purchased

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Practice Problem #6

K Company produces three picnic products: koolers, baskets and grills. A product line
income statement for the year is shown below:

Koolers Baskets Grills Total


Sales $360,000 $600,000 $240,000 $1,200,000
Variable expenses 198,000 420,000 120,000 738,000
CM 162,000 180,000 120,000 462,000
Fixed expenses 240,000
Operating income $262,000

Required: a) Prepare a product line income statement at break-even.


b) If the company stops producing and selling grills because sales are
low, fixed expenses will decrease $60,000. Prepare a product line
income statement at break-even.
c) If the company opens a sales office in Argentina next year, sales
are expected to double. Prepare a product line income statement
at the new sales level.
d) In second year in Argentina, total grill sales are expected to be
$800,000. Sales of all other products will increase an additional
10%. Fixed costs will increase $140,000. Prepare a product line
income statement.

Practice Problem #7

The following information is for a product manufactured and sold by R Company:

Selling price per unit $70


Variable cost per unit $40
Total fixed costs $600,000
Profit $30,000

Required: a) How many units did Richards sell last year?


b) Management is considering decreasing the sales price to $60 in an
effort to increase market share and reach a profit of $60,000. How
many units would it have to sell at the lower selling price to
achieve this target?

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Practice Problem #8

Shown below is a cost-volume-profit graph.

120

100

80
Dollars

60

40

20

0
0 20 40 60 80 100 120
Units of activity

Required: a) Label all parts of the graph

Following are several independent scenarios. For each scenario, identify


whether the breakeven point will change, and if so, how.
b)
c)
d)
e)
f)
g)
h)
i)
j)

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True / False Questions


1. Contribution margin is equal to fixed costs at the break-even point.
True False

2. Break-even units equals fixed costs divided by unit contribution margin.


True False

3. Target units equals fixed costs plus target profit divided by the unit
contribution margin.
True False

4. The target sales level equals fixed costs plus variable costs divided by the
contribution margin ratio.
True False

5. Margin of safety is the difference between actual sales and budgeted sales.
True False

6. Cost-volume-profit analysis can be used to evaluate changes in cost structure.


True False

7. The degree of operating leverage can be multiplied by a change in sales to


determine change in profit.
True False

8. In multiproduct cost-volume-profit analysis, a break-even point must be


calculated separately for each product.
True False

9. If the unit contribution margin is $1 and unit sales are 15,000 units above the
break-even volume, then net income will be $15,000.
True False

10. A target net income is calculated by taking actual sales minus the margin of
safety.
True False

11. If variable costs per unit are 70% of sales, fixed costs are $290,000 and target
net income is $70,000, required sales are $1,200,000.
True False

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12. Cost-volume-profit analysis assumes that all costs can be accurately described
as either fixed or variable.
True False

13. On a CVP graph, the break-even point is the point at which the contribution
margin line crosses the total cost line.
True False

14. Break-even units can be found by dividing fixed costs by unit contribution
margin.
True False

15. The target sales level equals fixed costs plus variable costs divided by the
contribution margin ratio.
True False

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Multiple Choice Questions


1. Which component of the income statement should be set equal to zero to find
the breakeven point?
a) Total sales revenue
b) Total variable costs
c) Total fixed costs
d) Profit

2. The equation for an income statement is


a) Unit price  Q – Unit variable costs  Q – Total fixed costs = Profit
b) Unit price  Q – Unit variable costs  Q + Total fixed costs = Profit
c) (Unit price – Unit variable costs – Total fixed costs)  Q = Profit
d) Unit price  Q + Unit variable costs  Q + Total fixed costs = Profit

3. The formula for break-even point in terms of units is


a) Total variable costs/Unit contribution margin
b) Total fixed costs/Contribution margin ratio
c) Total fixed costs/Unit contribution margin
d) Total variable costs/Total fixed costs

4. J Company has a selling price of $15, variable costs of $10 per unit, and fixed
costs of $25,000. How many units must be sold to break-even?
a) 5,000
b) 10,000
c) 2,500
d) 1,667

5. A Company has a contribution margin of 40% and fixed costs of $120,000.


What is the break-even point?
a) $48,000
b) $300,000
c) $200,000
d) $72,000

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6. P Company has fixed costs of $200,000, sales price of $50, and variable cost of
$30 per unit. How many units must be sold to earn profit of $50,000?
a) 2,500
b) 10,000
c) 12,500
d) 25,000

7. H Company has sales of $400,000, variable costs of $12 per unit, fixed costs of
$100,000, and a target profit of $60,000. How many units were sold?
a) 10,000
b) 15,000
c) 20,000
d) 25,000

8. B Company has fixed costs of $20,000 and a contribution margin ratio of 40%.
Currently, sales are $75,000. What is Bowl's margin of safety?
a) $20,000
b) $25,000
c) $30,000
d) $50,000

The next 2 questions refer to the following information.


G Company currently sells 15,000 units a month for $50 each, has variable
costs of $20 per unit, and fixed costs of $300,000. G Company is considering
increasing the price of its units to $60 per unit. This will not affect costs.

9. If the price is changed, demand is expected to drop by 20%. The effect on


profit will be:
a) Increase of $30,000.
b) Increase of $150,000.
c) Decrease of $150,000.
d) Decrease of $30,000

10. If the price is changed, how many units will G Company need to sell for profit
to remain the same as before the price change?
a) 10,000 units
b) 11,250 units
c) 12,000 units
d) 12,500 units

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11. Y Company is debating whether to change its cost structure so that fixed costs
increase from $300,000 to $400,000, but variable costs decrease from $5 per
unit to $4 per unit. If it were to implement the change at its current production
level of 100,000, profit would not change. What would happen to the
company's profit if the change were implemented and production increased to
125,000?
a) It will stay the same.
b) It will increase.
c) It will decrease.
d) It could increase or decrease

12. Degree of operating leverage is calculated as


a) profit divided by contribution margin
b) break-even sales divided by profit.
c) profit divided by break-even sales.
d) contribution margin divided by profit

13. F Company has a contribution margin of $450,000 and profit of $150,000. If


sales increase 20%, by how much will profits increase?
a) 20%
b) 30%
c) 60%
d) 90%

14. N Company sells two products. Product A sells for $100 per unit, and has unit
variable costs of $60. Product B sells for $70 per unit, and has unit variable
costs of $50. Currently, N Company sells three units of product B for every one
unit of product A sold. N Company has fixed costs of $750,000. How many
units would N Company have to sell to earn a profit of $250,000?
a) 40,000 units of A and 40,000 units of B
b) 10,000 units of A and 30,000 units of B
c) 30,000 units of A and 10,000 units of B
d) 20,000 units of A and 20,000 units of B

15. Profit is indicated on a cost-volume-profit graph by


a) the profit line.
b) the horizontal difference between the revenue line and the cost line.
c) the vertical difference between the revenue line and the cost line.
d) the horizontal distance from the breakeven point.

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16. Last month K Company had a $30,000 profit on sales of $250,000. Fixed costs
are $60,000 a month. What sales revenue is needed for Calico to break even?
a) $166,667
b) $90,000
c) $30,000
d) $280,000

17. Last month C Company had a $15,000 loss on sales of $150,000. Fixed costs
are $60,000 a month. How much do sales have to increase for Calico to break
even?
a) $60,000
b) $75,000
c) $45,000
d) $50,000

18. KV Company has fixed costs of $400,000 and a contribution margin ratio of
25%. How much sales revenue must be earned for a profit of $80,000?
a) $80,000
b) $400,000
c) $1,600,000
d) $1,920,000

19. S Company has sales of $105,000, variable costs of $4 per unit, fixed costs of
$25,000, and a profit of $20,000. What are the contribution margin and
contribution margin ratio?
a) $4.00 and 133%
b) $4.00 and 57.1%
c) $3.00 and 42.9%
d) $3.00 and 75%

20. T Company sells two products. Product A sells for $100 per unit, and has unit
variable costs of $60. Product B sells for $70 per unit, and has unit variable
costs of $50. Currently, T Company sells three units of product B for every one
unit of product A sold. Toyoda has fixed costs of $750,000. How many units
would T Company have to sell to earn a profit of $250,000?
a) 40,000 units of A and 40,000 units of B
b) 10,000 units of A and 30,000 units of B
c) 30,000 units of A and 10,000 units of B
d) 20,000 units of A and 20,000 units of B

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Solutions to Practice Problems


Practice Problem # 1

CM ratio = Sales – Variable Expenses = $90–63


Sales $90
= 30%

= Fixed expenses + Operating $21,000 + $0


Breakeven sales =
Income
Contribution margin ratio 30%
= $70,000

Margin of Safety in dollars= 2000x$90 - $70,000= $110,000


Margin of Safety percentage= $110,000/$180,000= 61%

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Practice Problem #2

a)
Present Breakeven
Units sold 10,000 10,000
Sales $600,000 $636,000
Variable expenses 420,000 420,000
Contribution 180,000 110,000
margin
Fixed expenses 110,000 110,000
Operating income $ 70,000 $0

CM Ratio 30% 17.3%

b)
I. II. III.
Units sold 4,000 3,200 4,200
Sales $264,000 $192,000 $252,000
Variable expenses 168,000 96,000 176,400
Contribution 96,000 96,000 75,600
margin
Fixed expenses 96,000 96,000 75,600
Operating income $0 $0 $0

CM Ratio 36.4% 50% 30%

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Practice Problem #3

a) Current income statement:


Red White Champagne Total
Bottles sold 100 40 60
Average selling price $80 $45 $60
Total sales $8,000 $1,800 $3,600 $13,400

Average cost $40 $15 $15


Total Cost $4,000 $600 $900 5,500
Contribution margin $4,000 $1,200 $2,700 7,900
Fixed expenses 3,160
Operating income $4,740

b) Breakeven income statement:


o Sales mix (proportion of bottles sold) of 10:4:6 remains constant although
the total number bottles may change. This means that of every 20 bottles
sold, 10 will be red, 4 will be white and 6 will be champagne.
o Contribution margin for the twenty bottles will be $790 (10x$40 + 4x$30 +
6x$45).
o At breakeven, fixed expenses = contribution margin.
o At breakeven, contribution margin of $3,120 / contribution margin of $790
for twenty bottles = 4 twenty bottle groups would be sold. Therefore, 40
bottles of red, 16 bottles of white and 24 bottles of champagne were sold.

Red White Champagne Total


Bottles sold 40 16 24
Average selling price $80 $45 $60
Total sales $3,200 $720 $1,440 5,360

Average cost $40 $15 $15


Total Cost $1,600 $240 $360 2,200
Contribution margin $1,600 $480 $1,080 3,160
Fixed expenses 3,160
Operating income $0

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Practice Problem #4

Next Year Year


Thereafter
Prior year Contribution margin $300,000 $330,000
Prior year Operating income $100,000 130,000
Degree of leverage 3.00 2.54
Percent increase in sales 10% 20%
Percent increase in operating 30.0% 50.8%
income
X operating income $100,000 $130,000
Increase in operating income $30,000 $66,000
Present operating income 100,000 130,000
Proposed operating income $130,000 $196,000

Practice Problem #5

F Company is debating whether to purchase new equipment that would increase fixed
costs from $96,000 to $196,000, and decrease variable costs from $14 per unit to $8
per unit. If it were to implement the change at its current production level of 100,000,
profit would not change. Selling price is $20 per unit.

Units Sold 20,000 20,000 15,000 16,334


Sales $20.00 $400,000 $20.00 $400,000 $300,000 $326,667
Variable $14.00 280,000 $8.00 160,000 120,000 130,667
CM $6.00 140,000 $12.00 240,000 180,000 196,000
Fixed 96,000 196,000 196,000 196,000
OI $44,000 $44,000 ($16,000) 0

At 15,000 units produced and sold, the company would have a net loss of $16,000.

Breakeven is $326,667 with 16,334 units sold.

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Practice Problem #6

Adding few basic calculations from the problem data (shown in bold) will make solving
the problem much easier.

a) Applying the percentages of total sales and the contribution margin ratios to a
break-even income statement (income = 0):
Koolers Baskets Grills Total
% Total Sales 30% 50% 20%
Sales $187,013 $311,688 $124,676 $623,377
Variable expenses 102,857 218,182 62,338 383,377
CM 84,156 93,506 62,338 240,000
CM Ratio 45% 30% 50% 38.5%
Fixed expenses 240,000
Operating income $0

b) Since grills have been discontinued, the percentages of total sales for the
remaining two products and the overall contribution margin must be recalculated:
Koolers Baskets Grills Total
% Total Sales 37.5% 62.5%
Sales $189,474 $315,789 $505,263
Variable expenses 104,211 221,052 325,263
CM 85,263 94,737 180,000
CM Ratio 45% 30% 35.625%
Fixed expenses 180,000
Operating income $0

Koolers % of sales: 30% / (100%-20%) = 37.5%


CM ratio = (37.5% x 45%) + (62.5% x 30%) =
35.625%

c) Percentages and cm ratios do not change when sales are increased:

Koolers Baskets Grills Total


% Total Sales 30% 50% 20%
Sales $720,000 $1,200,000 $480,000 $2,400,000
Variable expenses 396,000 840,000 240,000 1,476,000
CM 324,000 360,000 240,000 924,000
CM Ratio 45% 30% 50% 38.5%
Fixed expenses 240,000
Operating income $684,000

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d)
Koolers Baskets Grills Total
% Total Sales % % %
Sales $792,000 $1,320,000 $800,000 $2,912,000
Variable expenses 435,600 924,000 400,000 1,759,600
CM 356,400 396,000 400,000 1,153,400
CM Ratio 45% 30% 50% 39.6%
Fixed expenses 380,000
Operating income $773,400

Practice Problem #7

Last Year Next Year


Net Income $600,000 $600,000
Fixed costs 30,000 60,000
Contribution margin $630,000 $660,000

Per Unit:
Selling price $70 $60
Variable cost 40 40
Contribution margin $30 $20

Units required: 21,000 33,000

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Solutions to True / False Problems

1. True
2. True
3. True
4. False - Target sales level equals fixed costs plus target profit
divided by the contribution margin ratio.
5. False - The margin of safety is the difference between actual or
budgeted sales and break-even sales.
6. True
7. True
8. False - The break-even point is calculated for the entire company
using total contribution margin, weighted average
contribution margin ratio and total fixed expenses.
9. True
10. False - Target operating income is target contribution margin –
fixed expenses.
11. True
12. True
13. False - The break-even point is the point at which the total
revenue line crosses the total cost line.
14. True
15. False - Target sales level equals fixed costs plus target profit
divided by the contribution margin ratio.

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Revised Summer 20156 Chapter Review

Solutions to Multiple Choice Questions


1. D
2. A
3. C
4. A
5. B
6. C
7. C
8. B
9. A
10. B
11. B
12. D
13. C
14. B
15. C
16. A
17. D
18. D
19. C
20. B

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